A ‘Silver Bullet’ That Could Kill Your 401(k)

A new academic paper claims to have a solution to the problem of low-income retirement savings, oh, and they’d like you to pay for it.

The proposal [i] —put forth by folks at the Wharton School of the University of Pennsylvania is airily described as follows: “a new illustrative plan designed by the Penn Wharton Budget Model (PWBM) in response to policymaker questions may well be their silver bullet to have a decent-sized nest egg without actually having to save more than what they already do. Employers are also not burdened with higher administrative costs or contributions. The plan does not increase the federal deficit.”[ii]

It will, however, cost you your pre-tax savings incentive.

That admission isn’t buried in the fine print, though you DO have to scroll down several paragraphs to find it. Even so, it’s couched in phrases that make it sound as though the same individuals giving up that pre-tax incentive are the ones getting the benefit of this program. See what you think:

“In its design, the retirement pool will grow with the federal government making annual contributions to the individual retirement savings accounts; households or employers are not required to make any contributions. In exchange, those individuals[iii] would give up the tax breaks they receive for investing in 401(k) retirement accounts.”

However, “those” individuals—the ones “giving up those tax breaks”—well, that’s everybody who is currently saving on a pre-tax basis—which, it seems fair to say is a whole lot of people who WON’T be eligible for this new government program. For that group,[iv] and based on whichever assumption you want to apply for the government contribution, this proposal would purportedly wind up providing them with account balances of $100,000 to $200,000, depending on some assumptions.[v]

Ironically, this proposal—“funded exclusively by the federal government” (seriously? Let’s face it, funded by taxpayers)—isn’t, unlike the current tax preferences they are proposing to eliminate, a DEFERRAL of tax obligations—it is a flat out forbearance. And the researchers are apparently familiar with the way the federal government does its accounting, as it focuses strictly on a 10-year budget window in its assertion that it’s an even “trade”—ignoring the tax revenues that will be returned to the federal government—with interest—from the current pre-tax deferrals.?

Interestingly enough, an additional rationale for the “solution” is because the programs currently designed to provide that low-income support—Medicare and Social Security—are, in the words of the authors of this “new” idea—“severely underfunded.” So, we might as well double down, right?

Not that the folks at Wharton are claiming ownership for the idea. “We’re not proposing anything, saying Congress should do this,” Kent Smetters, Wharton professor of business economics and public policy and faculty director at PWBM said. “We’re just simply showing how it could be done.”

Honestly, this seems to be just an arithmetic exercise—one done by academics that have chosen to run some hypothetical numbers, completely ignore human behaviors, disregard factual information about the income composition of current retirement plan participants—and most particularly the impact on middle income savers who most assuredly DO enjoy and appreciate the tax deferral as an incentive to save, equate the temporary deferral of taxes in a 10-year budget window with the fiscal reality of simply handing out government contributions—and then effectively shrug at the notion that they are actually proposing an approach that they have spent time, energy and money developing, publishing, and—it seems fair to say—promoting.

That said, it seems to me that such proposals should be willing to be honest about the actual cost of such a proposal, rather than disingenuously pretending that it’s basically a “free” trade-off with no implications for retirement security or government finances. Like most so-called “silver bullets,” this one is overly simplistic—myopically focused on solving one issue, while completely discounting the long-term costs and implications of its application.

Those looking for a silver bullet—should keep looking.

[i] ?How Low-income Households Can Secure Their Retirement Finances

[ii] As discussed later, it makes that claim looking only at a 10-year federal government budget window—outside that, the results would be quite different.

[iii] Emphasis mine.

[iv] More specifically, the individuals they are directing these benefits to are simply described as “low-income Americans”—but winding your way through the proposal you can discover that eligibility defined as being “…based on the criteria used by existing Earned Income Tax Credit program: Individuals must be between ages 25 and 64, and they must have investment income below $10,000 (based on 2020 dollars, indexed to inflation over time.”

[v] The proposal says that the government would make contributions of 10% of earned income that reach a maximum of $2,000, $2,250, and $2,500 under those three scenarios, respectively; contributions are phased out at a rate of 30% starting at $50,000 of earned income.?

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